International Markets

Last month Turkish president Recep Tayyip Erdoğan appealed to his citizens to convert their foreign currency into gold or Turkish liras. The Turkish currency has lost about one-fifth of its value so far this year.

About the Author

Steven G. Kelman is president of Steven G. Kelman & Associates Limited. His company provides specialty publications and training for the mutual fund industries. Steven is the author of several personal finance books and is author or co-author of courses offered by the Investment Funds Institute of Canada, including the Ethical Conduct and Behaviour continuing education course and the Labour-Sponsored Investment Funds course. He received a B.Sc. from McMaster University, an MBA from York University and holds a Chartered Financial Analyst designation.

I suspect that very few of his subjects will take his advice, given the Turkish economic environment since the attempted coup last summer, mass arrests, and the view held by many people everywhere that investment advice from politicians, unless accompanied by incentives, should be ignored.

Furthermore, cynics might expect that President Erdoğan's plea to buy gold will be followed by its confiscation should Turkey's foreign exchange reserves be depleted. Add to that the fact that gold has been a dismal performer since July, when it was trading at just over US$1,365. Its recent price was about US$1,132 for a decline of about 17%. In Canadian dollar terms, its decline is about 15%, and when measured against the euro and UK pound, 12% and 14% respectively.

President Erdoğan would benefit from the example set by King Canute who demonstrated to his subjects that no one can turn back a tide. Some might say the same about President-Elect Donald Trump, who promises to make America great again through massive spending on infrastructure and through renegotiating with or bullying U.S trading partners for trade concessions.

Gold is a relatively thin trader so it doesn't take much selling to send prices lower. Moreover, the sale doesn't have to be in physical gold. It can be in derivatives. So, what we are seeing are perceived opportunities to make more money in the stock and bond markets than holding gold for the near term. The U.S. Federal Reserve's short-term interest rate hike and indications of further hikes next year does not bode well for gold prices in 2017.

That said, don't bet the family farm on continuing lower gold prices. First, there are no guarantees that interest rates will move higher several times in 2017, just as they did not move several times in 2016 after initial Federal Reserve expectations that it would. Also, the stock market rally since the presidential election last month is based on those expectations of government spending on infrastructure and what seems to be perceptions that manufacturing jobs that have been lost to lower-cost countries will return.

Government spending could prove inflationary, which would improve the outlook for gold. Repatriating jobs from China, Mexico and elsewhere, if it's even possible, would be expensive and inflationary, as well, and could lead to trade disruptions that would hurt the U.S. economy -- again putting a shine on gold.

Higher interest rates attract capital and push up the U.S. dollar. But if rate hikes have a negative impact on consumer confidence and spending and, in turn, economic growth, the dollar will suffer to gold's advantage as some investors look for something better than the dollar.

At the same time, there is reason to be nervous about Europe's outlook and what the Organisation for Economic Co-operation and Development refers to as "banking sector fragilities and uncertainties about European integration" in an economic report last month. Any bank failures will, of course, hurt confidence.

There are also concerns that some European Union members will follow Britain and leave the union. While this may not happen, changes to sovereign governments that are less supportive of the EU and its control over monetary policy would lower confidence in the euro. In such circumstances, gold prices would almost certainly benefit as some euro holders decide to put their capital elsewhere.

Outside of investment, jewellery is the main market for gold. According to the World Gold Council, demand for gold jewellery in the third quarter was down 21% year over year in major markets which include India, China, the Middle East, the United States and Europe.

India is a special case. Business in India is largely conducted on a cash basis, which makes taxation somewhat difficult. India's solution was to ban last month the use of 500 and 1,000 rupee notes, giving holders to the end of the year to turn them in for new legal tender. Of course, sophisticated tax evaders would have converted their cash on an ongoing basis to gold, property and foreign assets. Anyone else would be scrambling to convert their currency regardless of its source. Reports of large notes selling at deep discounts suggests that there are ways around the new rules. Furthermore, prices in what is a gold market with significant duty on gold imports have jumped.

What impact the government's move will have on gold demand in the months ahead is anyone's guess. The government has stated it has no intention of banning gold ownership. But traditional demand for gold in India and elsewhere suggests that traditional demand reflects a traditional distrust of government.

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